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1 George Mason School of Law Contracts II Warranties F.H. Buckley

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1 1 George Mason School of Law Contracts II Warranties F.H. Buckley

2 2 Conditions and Warranties Promises ConditionsWarranties Election Forfeiture DamagesDamages only

3 Warranties With a warranty a seller assumes a risk as to the product The prior question is whether the risk should be born by the seller or the buyer 3

4 4 Lets say seller sells a whizbang

5 5 The whizbang 50% chance of a whiz It might go whiz

6 6 The whizbang 50% chance of a whiz, 50% of a bang It might go whiz … or it might go bang …

7 7 The expected monetary value of an accident is p*L Evaluating risk: Expected Values

8 8 The expected monetary value of an accident is p*L where p is the probability of occurrence And L is the cost of the accident on occurence Evaluating risk: Expected Values

9 9 So the expected monetary value for an accident with a 50 percent probability of a loss of $250 is $125 Evaluating risk: Expected Values

10 10 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs The Least-Cost Risk Avoider

11 11 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 The Least-Cost Risk Avoider

12 12 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 The Least-Cost Risk Avoider

13 13 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 Seller is the least-cost risk avoider The Least-Cost Risk Avoider

14 14 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? The Least-Cost Risk Avoider

15 15 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk The Least-Cost Risk Avoider

16 16 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk And what will this do to the purchase price? The Least-Cost Risk Avoider

17 17 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk What is the range of prices between which the parties will bargain? The Least-Cost Risk Avoider

18 18 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk Seller will not accept less than $100 and (risk-neutral) buyer will not pay more than $125 The Least-Cost Risk Avoider

19 19 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Buyer (but not Seller) can eliminate this risk at a cost of $100 What happens now? Lets flip this Buyer as Least-Cost Risk Avoider

20 20 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Buyer (but not Seller) can eliminate this risk at a cost of $100 Buyer will spend $100 to eliminate a risk with an EMV of $125 Lets flip this Buyer as Least-Cost Risk Avoider

21 21 The parties will seek to assign the risk to the party who can most efficiently eliminate it. The Least-Cost Risk Avoider

22 22 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem If bargaining is costless, does it matter who bears the risk? The Least-Cost Risk Avoider

23 23 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem And if bargaining isnt costless? The Least-Cost Risk Avoider

24 24 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Youre a judge. You have a pretty good idea who the least-cost risk avoider is. The parties have left the question of risk silent in their contract. How do you assign the risk? The Least-Cost Risk Avoider

25 25 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Mimicking the market The Least-Cost Risk Avoider

26 26 Same example. But now neither party can eliminate the risk for less than $125. On whom should the risk fall? Does it matter? A second way of thinking about Least-Cost Risk Avoiders

27 27 Same example. But now neither party can eliminate the risk for less than $150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? A second way of thinking about Least-Cost Risk Avoiders

28 28 Same example. But now neither party can eliminate the risk for less than $150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? Do risk preferences matter? A second way of thinking about Least-Cost Risk Avoiders

29 Are you an EMVer? An EMVer always selects the payoff with the highest expected monetary value (p*O) 29

30 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (p*O) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $2. Would you pay me 50¢ for the ticket? 30

31 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $2. Would you pay me 50¢ for the ticket? EMV =.5($2) = $

32 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $10,002. Would you pay me $5,000 for the ticket? 32

33 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $10,002. Would you pay me $5,000 for the ticket? EMV =.5($10,002) = $5,001 33

34 34 Three kinds of people EMVers are risk neutral They always take the gamble with the highest EMV

35 35 Three kinds of people EMVers are risk neutral Most people are risk averse Theyll pass on some opportunities with a positive EMV

36 36 Three kinds of people EMVers are risk neutral Most people are risk averse Risk lovers are risk prone They will accept some gambles with a negative EMV

37 37 Recall what we said about utility Utility is the economists measure of well-being (cf. utilitarianism) Ordinal Utility measures preferences without weighing them (first, second, third are ordinal numbers) Cardinal Utility (Benthams utils) weighs utility (one, two, three are cardinal numbers)

38 38 Cardinal Utility plotted against EMV Utility $EMV For EMVers, utility is linear with money

39 39 Cardinal Utility Utility $EMV For the risk averse, the marginal utility of money declines (more money generates increasingly smaller increases in utility).

40 40 Cardinal Utility Utility $EMV A justification for progressive income taxation?

41 41 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 Would you assume that firms are risk- neutral and consumers risk averse as to a loss of $250? This suggests a second way of thinking about Least-Cost Risk Avoiders

42 42 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 Would you assume the firms are risk- neutral and consumers risk averse? Would you expect the risk to be born by the wealthier party? This suggests a second way of thinking about Least-Cost Risk Avoiders

43 43 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 On whom should the risk fall? Does it matter? Suppose that seller sells 10,000 whizbangs and buyer buys only one? Does that make a difference? Now--A third way of thinking about Least-Cost Risk Avoiders

44 Probability distribution for buyer 44 $EMV 7501,000 $750 %.5

45 Probability distribution for seller of 60 whizbangs 45 $EMV %.5 875

46 Probability distribution for seller of 10,000 whizbangs 46 $EMV 875 % 1.0

47 Probability distribution for seller of 10,000 whizbangs % 1.0 All Curves have the same mean value ($875) but different risk (dispersion from the mean).

48 Probability distribution for seller of 10,000 whizbangs % 1.0 All Curves have the same mean value ($875) but different risk (dispersion from the mean).

49 Probability distribution for seller of 10,000 whizbangs 49 $EMV 875 % 1.0

50 50 1.Where one party is better able to reduce the risk or the harm (or to value the loss) 2.Assuming risk aversion, where one party is wealthier than the other 3.Assuming risk aversion, where one party is a better insurer because he can diversify the risk Three kinds of Least-Cost Risk Avoiders

51 51 Where one party is better able to reduce the risk or the harm (or to value the loss) Assuming risk aversion, where one party is wealthier than the other Assuming risk aversion, where one party is a better insurer because he can diversify the risk Where might third party insurance substitute? Three kinds of Least-Cost Risk Avoiders

52 52 Where might third party insurance substitute? Liability for a faulty transmission? Break-in of a house? Emotional Distress World War III? Three kinds of Least-Cost Risk Avoiders

53 Sessa v. Riegle Was there a finding that the horse that was sold was defective? 53

54 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the later case, buyer took the risk 54

55 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the former case, who took the risk? UCC §§ 2-501(1)(a),

56 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable Thrombosis might have been a pre- existing latent condition Might the seller be liable for this? 56

57 Sessa v. Riegle Was this a promise that the horse would be sound after the sale Like a 5 year warranty on a sale of a car? 57

58 Sessa v. Riegle Was this a promise that the horse would be sound after the sale E.g. 5 year warranty on a sale of a car Was this a promise that the horse was sound at the time of the sale? the horse is sound the horse is a good one you will like him 58

59 Sessa v. Riegle Why not within UCC §2-313? 59

60 Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact? Statements of opinion: UCC §2-313(2) Mere puffs 60

61 Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact Statements of opinion: UCC §2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures 61

62 Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact Statements of opinion: UCC §2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures Frederickson Distinguish McNair What if soundness was guaranteed 62

63 Royal Business Machines Copy machine: Was of high quality Frequency of repair was very low Would remain so Will bring buyer substantial profits 63

64 Royal Business Machines Copy machine: Machines were tested 64

65 Royal Business Machines Copy machine: Machines will not cause fire 65

66 Specificity: Searls v. Glasser recession resistant? Keith: sure-footed seaworthiness? 66

67 67 George Mason School of Law Contracts II Warranties F.H. Buckley

68 Flippo Remedy in tort? 68

69 Flippo Remedy in tort? Remedy in contract? What were the goods? 69

70 Flippo Remedy in tort? Remedy in contract? Implied warranty of merchantability What were the goods? Cf. Prosser on p. 672 UCC § 2-313B 70

71 Implied UCC Warranties Merchantabilty: UCC § Fitness: UCC §

72 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt

73 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt. 13 Does reliance come into this? 73

74 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt. 13 Does reliance come into this? I sell you a car which proves unsuitable for off-terrain driving 74

75 Fitness: UCC § How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance 75

76 Fitness: UCC § How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance Why no warranty in Lewis and Sims at 674? 76

77 Warranty of Workmanlike Performance Construction and services contracts Could any contractor be thought to resist such a duty? 77

78 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average 78

79 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) 79

80 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) What if it had been proven that seller knew it was a clunker. Morris v. Macks 80

81 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) What if seller in Pelc had said its in perfect condition or I guarantee its in good shape 81

82 Exemption Clauses Does an as is clause exclude express warranties? Only if not unreasonable UCC § (1) 82

83 Exemption Clauses What were the warranties in Pelc? Qu. the finding that the representations were not improper? 83

84 Exemption Clauses What were the warranties in Pelc? Qu. If the representations had been fraudulent? 84

85 Weisz v. Parke-Bernt Can you spot the fake Van Gogh? 85

86 Weisz v. Parke-Bernt Why was the exemption clause ignored? 86

87 Weisz v. Parke-Bernt Just what is a Raoul Dufy?? 87

88 Weisz v. Parke-Bernt The old fundamental breach doctrine 88

89 Substantial Performance vs. Perfect Tender Perfect tender required in UCC § Substantial Performance Restatement § 229 (no disproportionate forfeiture unless material event) Restatement § 237 (no uncured material failure 89

90 Substantial Performance vs. Perfect Tender Perfect tender required in UCC § Substantial Performance Restatement § 229 (no disproportionate forfeiture unless material event) Restatement § 237 (no uncured material failure Materiality defined in §

91 Substantial Performance in Jacob & Young 91

92 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? 92

93 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? 93

94 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Could you draft a clause that would have given Kent a right to rescind? 94

95 What is Reading Pipe? This is Reading Pipe

96 This is not Reading Pipe

97 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Would the parties have agreed to such a clause? Why not? 97

98 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? 98

99 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? What is substantial performance for a roof? 99

100 Haymore v. Levinson 100

101 Grun Roofing vs. Haymore Personal taste or fancy vs. operative fitness mere taste may be controlling in the former case 101

102 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? 102

103 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? The substantial performance standard 103

104 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? Would perfect tender open the door to opportunism? 104

105 105 Things looked simple at common law Promises ConditionsWarranties Election Forfeiture DamagesDamages only

106 Theyre more complicated in the UCC Buyers Remedies Perfect Tender required Conforming goods

107 Buyers Remedies in the UCC Perfect Tender required Accept2-606Reject

108 Buyers Remedies in the UCC Perfect Tender required Accept2-606Reject Action for price paid Incidental Damages 2-711, Cover 2-711,

109 Cure by Seller Perfect Tender required Accept2-606Reject Cure 2-508Dont cure 109

110 Buyers Remedies in the UCC Perfect Tender required Accept2-606Reject Damages 2-714,

111 Buyers Remedies in the UCC Perfect Tender required Accept2-606Reject Damages 2-714, 2-715Revocation of Acceptance 2-608,

112 Buyers Remedies in the UCC Perfect Tender required Accept2-606Reject Damages 2-714, 2-715Revocation of Acceptance 2-608, Cancel 2-711, 2-106(4) Damages 2-711, Specific performance? 2-711(2) 112

113 Sellers Remedies Goods not deliveredGoods delivered Withhold delivery Stoppage in transitu Damages 2-703,

114 Sellers Remedies Goods not deliveredGoods delivered Action for the price Damages

115 115 George Mason School of Law Contracts II Warranties F.H. Buckley

116 Opportunism and Perfect Tender? The problem of buyer opportunism is addressed by the sellers right to cure 116

117 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? 117

118 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% 118

119 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% The price of oil had fallen by 25% 119

120 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: When was delivery to take place? 120

121 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: When was delivery to take place? When was the substitute delivery to occur? 121

122 Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: Before delivery date: 2-508(1) Cure after: 2-508(2) Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance 122

123 Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: Before delivery date Cure after Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance Must seller know that tender will be non- conforming? Nordstrom on Sales 123

124 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: Before delivery date Seasonably notify buyer---why? What if first tender is junk? 124

125 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date 125

126 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date Cf. proposed 2003 revision 126

127 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug

128 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? 2-508(2)

129 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods?

130 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods? Did buyers revoke acceptance and cancel? 2-608,

131 Can be waived by seller? Qu. Consumer goods where seller specifies goods satisfactory or money refunded I order a shirt on-line, which is torn. Can seller resend? 131

132 When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets 132

133 When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets In other cases, weakened cure rights? Zabriskie Chevrolet Might cure rights give sellers misincentive to cheat on terms? 133

134 134 George Mason School of Law Contracts II Anticipatory Repudiation F.H. Buckley


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